A radical simplification of economic forecasting models produces interesting, if controversial, results. Michael Lucy reports.
Deep down every physicist believes that, if they only had a spare six months, they could put the messy human science of economics on a more precise and rational footing. A team of Italian physicists is trying to make the daydream a reality, but they are finding the job takes a little longer.
“We have been working on this for around six years now,” says Andrea Tacchella of the Institute for Complex Systems in Rome, the first author of a paper on the research published in the journal Nature Physics.
Led by Luciano Pietronero of Sapienza University of Rome, the researchers used publicly available export data to produce five-year gross domestic product (GDP) forecasts for countries around the world. The results are on average 25% more accurate than those of the International Monetary Fund.
The field of economic complexity studies the economy with tools from the discipline-straddling science of complex systems. It involves webs of large numbers of elements (such as atoms, or animals or companies) that interact with each other in complicated, non-linear ways. These interactions create coherent structures and “emergent” properties.See also:
Seen in this way, economics bears a relationship to the flow of a turbulent fluid or the behaviour of a traffic jam, and might – just might – be described by a relatively simple set of rules.
The team’s aim, they write, is a “fundamental rethinking of economic modelling hat goes in the direction of a more scientific and less dogmatic approach”.
A country’s economy is a complex system par excellence: millions of individual humans interacting with each other in a movable maze of possibilities and constraints ranging from the physical availability of resources to education levels and fiscal policies, all while the country itself is furiously exchanging goods, services and people with the rest of the world.
Traditional forecasting techniques might try to take hundreds of these variables into account, but Pietronero’s team instead aimed at radical simplification. They built a model with only two variables: the first is the country’s current GDP and the second what they call “economic fitness”.
“Fitness is an indicator of how much a country’s export products are diversified, weighted by how complex its products are,” says Tacchella. So, the broader the range of products a country exports, and the more complex they are, the more fit it is deemed to be and the more strongly its GDP is likely to grow. (An extra non-linear snarl is added by the calculation of the complexity of a product: it is determined by the fitness of all the countries that produce it.)
The results are certainly promising. In 2015, the method correctly suggested the Chinese economy would keep growing strongly, when many other forecasts said it was headed for a sharp slump. And retrospective use of the method revealed trouble ahead for Brazil and Russia as early as 2005, when the likes of Goldman Sachs were predicting they would be economic powerhouses of the twenty-first century....MORE
"Few things are as dangerous as economists with physics envy"
May 26, 2010
"WARNING: Physics Envy May Be Hazardous To Your Wealth!"
I had a similar, albeit intuitive rather than empirical, thought in the June '09 post "Climateer Investing on Carbon Trading and Traders":
...Just as an economist using the tools of science (mathematics) doesn't make economics a science, carbon traders using the tools of markets doesn't make carbon trading market based....From the abstract at Physics arXive:...
June 3, 2015
Economists don't have "physics envy"
I hear all the time that economists have "physics envy". This doesn't seem even remotely true. I'm not sure whether "physics envy" means that economists envy physicists, or that economists want to make physics-style theories, or that economists wish their theories worked as well as those of physicists. But none of these are true.
Reasons why economists don't have physics envy include:
1. Economists make a lot more money than physicists.
2. Economists are treated as experts on practically anything. An economist can talk about why hipsters have moustaches, and get taken seriously. An economist can talk about which restaurants are the best, and get taken seriously (Update: NO, I'm not saying Tyler's book is bad, I haven't even read it, so HUSH). An economist can talk about politics, marriage, popular music, sex, race, or sports and get taken as seriously as any expert in those fields. An economist can talk about how much progress physicists are likely to make, and get taken seriously. Physicists get taken seriously when they invent quantitative rules for things, but otherwise are treated as just one more tribe of crazy nerds with their heads in the aether....
So there you go.
Except for point 1.
If that physicist happens to be running a quant fund in Greenwich even the richest economist in history is a pauper by comparison.